Semiconductor design software company TECHNOLOGY MODELING ASSOCIATES (Nasdaq: TMAI) booted up $2 1/2 to $16 after announcing an agreement to merge with AVANT! (Nasdaq: AVNT). Software firm Avant! is still battling a civil suit filed by CADENCE DESIGN (NYSE:CDN) as well as criminal indictments from Santa Clara County, California, both alleging theft of Cadence's IC-CAD source code. Despite Avant!'s troubles, Technology Modeling agreed to the stock swap, and the deal will be structured as a tax-free reorganization accounted for as a pooling of interests. The total value of the deal is estimated at close to $150 million. With Technology already providing computer-aided design software (CAD) to major semiconductor makers, this product will round out Avant!'s own integrated circuit design software offerings.
FUQUA ENTERPRISES (NYSE: FQE) moved up $5 15/16 to $32 5/16 on announcing an agreement to merge with GRAHAM-FIELD HEALTH PRODUCTS (NYSE: GFI) in a stock swap valuing Fuqua shares between $28.50 and $37 apiece. Graham-Field will trade up to 2.1 of its shares for every Fuqua share, subject to upward revision. Graham-Field is a low-cost provider of over 23,000 medical and surgical products, and with this acquisition the company is positioned to become one of the leading suppliers of durable medical products in the healthcare industry. The enhancement of product line, manufacturing capability, and penetration into the long-term care segment were all cited as reasons for the merger.
Seismic data acquisition equipment manufacturer INPUT/OUTPUT INC. (NYSE: IO) rumbled $3 13/16 higher to $27 9/16 after reporting record quarterly revenues of $83 million and Q1 EPS of $0.26, beating estimates of $0.16. A key feature of the quarter's results was an improvement in gross margin from 31% to 40%, which was attributed to organizational changes carried out in the final quarter of its 1996 fiscal year. Part of the $10.6 million charge taken in that quarter included a write down of the company's capitalized exploration costs, which may be a factor in this quarter's results (but not in the gross margin calculation). The company feels it can maintain these margins going forward, so expect a rush to revise earnings expectations.
QUICK TAKES: Shares of US AIRWAYS GROUP (NYSE: U) flew $2 3/4 higher to $37 3/4 after saying it has offered its pilots an enhanced agreement that would place them "above their counterparts at other major airlines" with respect to job security and rate of job growth... In other airline news, SOUTHWEST AIRLINES CO. (NYSE: LUV) today launched nonstop service to and from Florida with flights to Orlando and Tampa Bay, which was good a gain of $2 1/4 to $32... TRANS WORLD AIRLINES (AMEX: TWA) said it will acquire an additional Boeing 767-300 aircraft through a leasing agreement, but this wasn't the reason for the shares' $13/16 rise to $8 1/8 today, as airlines are up across the board on the latest round of fare increases... CUBIC CORP. (AMEX: CUB) rose $4 3/4 to $39 1/8 after this weekend's Barron's ran an article that was positive on the company and its new product named CVideo Mail, which incorporates sound and video with electronic mail messages and is expected to be in full commercial distribution by year-end.
Residential developments builder HOVNANIAN ENTERPRISES (AMEX: HOV) added $1/2 to $7 5/16 after posting 3Q EPS of $0.27, way above estimates of $0.17... ROYALE INVESTMENTS (Nasdaq: RLIN), a real estate investment trust, said it signed a definitive agreement to combine with the Mid-Atlantic suburban office operations of The Shidler Group, a national real estate investment firm, which gave Royale shares a $2 5/16 lift to $7 7/8... Internet "money" company CYBERCASH INC. (Nasdaq: CYCH) moved up $3 7/8 to $22 3/8 after it announced the availability of two new CyberCash payment components for the Microsoft Wallet and Microsoft Commerce Server... In a bid to further expand its web presence, Internet bookseller AMAZON.COM INC. (Nasdaq: AMZN) booked a gain of $6 to $36 after announcing the expansion of an existing incentive program to recruit the "Top 500 PC Meter" sites as Premium Associates... Firewall software company RAPTOR SYSTEMS (Nasdaq: RAPT) clawed its way $2 5/8 higher to $16 5/8 after Chairman Robert Steinkrauss said analysts' earnings estimates for 1998 were "conservative."
BASIN EXPLORATION (Nasdaq: BSNX) added $2 1/8 to $13 5/8 after the oil and gas exploration firm announced that it hit oil and gas at two drilling sites in the Gulf of Mexico... AML COMMUNICATIONS (Nasdaq: AMLJ) rose $1 11/16 to $8 3/4 after the wireless telecom equipment manufacturer received a Van Kasper & Co. rating upgrade to "buy" from "hold"... Internet security company CYLINK CORP. (Nasdaq: CYLK) said it signed a definitive agreement to acquire Israel-based Algorithmic Research, an information security company, for $44 million in cash and 2,976,923 common shares valued at $38.7 million... Maker of disposable industrial garments LAKELAND INDUSTRIES (Nasdaq: LAKE) posted 2Q EPS of $0.18, raising the stock $13/16 to $6 5/16... Montgomery Securities started coverage of AMERICAN COMMUNICATIONS SERVICES (Nasdaq: ACNS) with a "buy" rating, boosting shares of the local fiber network operator $1 1/8 to $9 1/4... Integrated circuit tester RELIABILITY INC. (Nasdaq: REAL) rose $4 1/2 to $39 5/8 after the company announced a two-for-one stock split.
Institutional pharmacy services company VITALINK PHARMACY SERVICES (NYSE: VTK) dropped $1 to $20 after the company and its majority owner, MANOR CARE INC. (NYSE: MNR), announced on Friday that they no longer object to the merger of eldercare providers LIVING CENTERS OF AMERICA (NYSE: LCA) and GRANCARE (NYSE: GC). Earlier this year, Vitalink acquired GranCare's institutional pharmacy services unit and believed that the merger between Living Centers and GranCare conflicted with a non-compete clause that was agreed to when Vitalink bought the GranCare unit. PaineWebber's analyst didn't like the move, downgrading Vitalink to "neutral" from "attractive" today.
CYMER INC. (Nasdaq: CYMI) fell another $12 7/8 to $69 1/8 after the maker of deep ultraviolet excimer lasers used in semiconductor wafer steppers sought to clear up why its CFO cancelled an appearance at a Needham & Co. investment conference. A press release regarding the cancelled conference appearance was rather oblique, but essentially said the company is unsure about near-term financial performance. Some investors were confused as to whether this was due to a supply or demand problem. With 80% or more of the market for these highly demanded systems, though, it is likely that the company could deliver on open orders if one or more customers pushed out their deliveries. Looking at another press release sent out this morning by Informed Investors Inc., production problems (seen last quarter as the company ramps up its unique products) appear to be the cause of the company's caution on results for the quarter.
GENERAL SIGNAL CORP. (NYSE: GSX) slid $5 13/16 to $38 15/16 after warning that 1997 EPS may drop $0.35 below analysts' earnings expectations, the First Call mean for which is $2.89 per share. The maker of uninterruptible power supplies, process control systems, valves, and other industrial goodies blamed reduced revenues, technical problems with two new products, and lower-than-expected productivity for the poor results. Lehman Brothers cut its rating on the company to "outperform" from "buy," and added that the company has a good restructuring plan in place and a balance sheet with $389 million in working capital.
Real estate investment trust REDWOOD TRUST (Nasdaq: RWTI) was cut down $10 11/16 to $29 1/8 after warning this morning that second half results for 1997 will be similar to first half levels. The company, which purchases mortgages and mortgage securities for single-family residential real estate, said that prices on mortgage assets are too high and that asset growth will likely suffer. EPS for 1997 is now forecast to grow 59% over last year, but investors don't like the slowing growth rates. Even if this company does miss out on some asset growth, its earnings growth still looks solid.
QUICK CUTS: Video rental stores operator HOLLYWOOD ENTERTAINMENT (Nasdaq: HLYW) got a thumb's down of $4 3/16 to $12 1/16 after Raymond James cut its rating on the company from "buy" to "hold"... AMERICAN OILFIELD DIVERS (Nasdaq: DIVE) fell $2 1/2 to $16 5/8 after the oilfield services company said it will miss the mean Q3 earnings estimate of $0.38 due to operating and financial factors including the write-off of intangible assets totaling $2 million... AMISTAR CORP. (Nasdaq: AMTA) slid $1 1/4 to $4 3/4 after the circuit board assembly machinery maker said it expects to see an operating loss and a revenue decline in the third quarter because of lower sales of its assembly machines... Medical device maker POSSIS MEDICAL (Nasdaq: POSS) lost $1 1/2 to $13 3/4 as investors were apparently underwhelmed by the company's Perma-Flow Coronary Bypass Graft that won a Humanitarian Device Exemption from the FDA.
Security technologies company BARRINGER TECHNOLOGIES (Nasdaq: BARR) dropped back $1 3/16 to $11 3/4 after the company announced late Friday that it won a $500,000 contract to supply drug and explosive detection equipment to the Mexican government... Nutritional supplements company WEIDER NUTRITION INTERNATIONAL (NYSE: WNI) lost $1 7/8 to $10 1/2 after saying it expects Q1 EPS of $0.07, which is $0.07 below estimates, due to startup costs at a new manufacturing facility... COMMSCOPE (NYSE: CTV) continued downward, losing $1 3/16 to $13 5/8, following last week's announcement from the world's largest coaxial cable manufacturer that earnings will fall significantly from the last quarter... Disk drive maker WESTERN DIGITAL (NYSE: WDC) fell $3 3/4 to $44 after Bear Stearns analyst Andy Neff worried that weak pricing for disk drives would hurt the company's first quarter results... Oil and gas contract driller UTI ENERGY CORP. (AMEX: UTI) fell $1 11/16 to $25 5/8 after announcing the registration for sale of 5.92 million shares, of which 4.34 million are being sold by shareholders.
FOOL ON THE
An Investment Opinion by Randy Befumo
CompuServed -- AOL, WorldCom divide and conquer the online service.
AMERICA ONLINE (NYSE: AOL) and WORLDCOM (Nasdaq: WCOM) divvied up COMPUSERVE (Nasdaq: CSRV) today in a series of asset swaps that will cement the dominance of both companies in online services and network services, respectively. The deals began when WorldCom purchased CompuServe in a stock swap valued at $1.3 billion. By swapping 0.40625 shares of its own stock for each share of CompuServe, WorldCom gained control of the online service and Internet access provider. WorldCom then went to America Online and traded CompuServe's 2.6 million subscriber online service and $175 million in cash for America Online's ANS Communications subsidiary, further extending WorldCom unit UUNET's lead in the network services and backbone business.
The ramifications to America Online's economic model as a result of this move are both profound and difficult to quantify. The deal gets America Online out of the network building business, allowing AOL Networks Chief Executive Bob Pittman to focus completely on America Online the service. The asset swaps combined with the cash infusion improve America Online's working capital position, clean up its cash flow, and potentially improves its cost structure. America Online will inherit the 2.6 million worldwide subscriber base that was built and managed under the CompuServe brand. The current thinking is to keep this as a separate brand focused on business and technical customers, leaving AOL as the broad-base consumer brand.
Although the CompuServe subscriber base is large and potentially lucrative, the immediate benefits appear to be in the overall company's cost structure. Almost all of the lease payments and costs that had been capitalized associated with ANS and the network disappear from AOL's rather complicated cash flow statement. America Online also gets a favorable five-year deal where it locks in all of the economic benefits it had hoped to get from owning ANS, meaning it gets all the reward with absolutely no execution risk. Furthermore, the company moves to a "portfolio" strategy to solve the access problem, getting service from UUNET, GTE/BBN, and Sprint. This allows it to play the suppliers off one another to get cost breaks and reduces the headache of supporting almost all of the back-end operations to just remembering to write checks at the end of the month.
Of course, no America Online story is ever complete without some complicated accounting. Whatever critics may say, America Online CFO Len Leader certainly earns his paycheck. The sale of ANS is being structured as a five-year sale-leaseback deal, meaning that AOL is selling the network and then leasing back the capacity over five years. Because of this, the company will amortize recognition of the $360 million gain from selling ANS over five years, reducing costs of good sold by $20 million each quarter. Before the number crunchers get too excited, however, they need to remember that this probably will be offset by amortization of the goodwill associated with the purchase of the CompuServe subscribers and a loss of the profits from the ANS unit. However, with the America Online focused on the services side of the business and someone else watching the network ball, it would be hard to imagine not seeing some benefit on the cost of goods sold line at some point in the future.
With $175 million from UUNET (basically CompuServe's $134 million in cash plus some change), $75 million from European media giant Bertelsmann AG for rights to 50% of CompuServe's European business, and the removal of the $37 million in negative working capital ANS Communications had on America Online's consolidated balance sheet, working capital improves by $287 million. Finally having positive working capital again allows America Online some additional financial flexibility and possibly scraps the proposed offering of equity in the Greenhouse venture capital unit that AOL Studios has been contemplating -- particularly given that the price the market was willing to pay was not all that generous. Investors must trust Case & Co. not to blow all of this money in the black hole that AOL Studios could theoretically become, but given the dramatic improvement on costs AOL Networks has seen in the past six months since the arrival of the Bob Pittman, this does not seem to be a serious worry at this point. For evidence of this, just look at marketing spending, which dropped from 40% of revenues to 20%, or look at employee headcount, which did not increase in the fourth quarter after months of explosion.
Enough about the cost structure -- what is the upside from the CompuServe subscriber base? America Online's customers generate $17.25 to $17.50 a month in usage fees (last quarter's $16.47 included large refunds) and $3.47 a month in "commerce" -- a blanket term for merchandise, advertising, and anything else it can sell. CompuServe does $14.40 a month in services and $0.18 a month in commerce, leaving room for a little upside. With an ad sales force already in place, seeing some sales of the CompuServe impressions certainly could be in the cards. Certainly America Online is better positioned than CompuServe was to yield some benefits from these customers. If it can, it will only further distance America Online's lead in the commerce segment. With America Online generating $80 million last quarter in commerce ($36 million in merchandise and $44 million in ads), Yahoo! comes in second or third with only $13.5 million in the same quarter (in spite of the fact that it carries a much higher valuation by any metric).
Once again, America Online has proven that it is willing to turn its financial model on a dime despite its increasing size. Rarely has a company this large been able to deal with changing market dynamics so quickly, although the pricing issue did take a while to finally settle down. As ANS Communications has long been difficult to value, it also may result in an improved valuation for America Online as a whole, as the capital expenditures required to build its business disappear from AOL's books. Although America Online has always reported the company's revenues, because much of its business was building and managing America Online's AOLNet at cost, it was hard to make apples-to-apples comparisons between it and other network services and backbone providers. Using valuations based on multiples to annualized sales or estimated sales that were awarded to UUNET, BBN, and Digex in recent acquisitions to value ANS was hard because so much of its business was done at a discount for its owner, America Online.
The ANS valuation mystery is solved today with the divestiture. Depending on how much you believe a CompuServe subscriber is worth, the real value of ANS was revealed today. By swapping ANS for 2.6 million CompuServe subscribers and $175 million, America Online not only recognized a substantial capital gain on a company it purchased in February 1995 for $20 million in cash and 1.0 million split-adjusted shares, but it also got a sweetheart services deal as well. The five-year, fixed price deal from UUNET to provide its network access could possibly be more valuable to America Online than the CompuServe subscribers and the cash. As demand for "bandwidth" increases at a rapid rate, most industry watchers have projected that prices will increase dramatically over this time period. No matter how you slice it, Case & Co.'s decision to buy ANS in February 1995 has created tremendous value for America Online shareholders, and the company appears to be moving in the right direction to continue this trend.
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